Rolls-Royce (LSE: RR) shares have been by far the biggest winner on the FTSE 100 over the last 12 months, up a thumping 216.05%. That’s way ahead of second-placed Marks & Spencer Group, which climbed ‘just’ 131.57% over the same period.
Performance figures like that are dangerous. Investors pile in hoping to make a fast buck, and risk taking a beating as the shares retrench.
However, this isn’t a struggling meme stock like GameStop and AMC Entertainment. Rolls-Royce is a serious business, with serious growth prospects, as well as a proud symbol of British engineering ingenuity.
Is it too late?
One reason the Rolls-Royce share price has risen so quickly is that it had fallen such a long way, after being hammered by repeated profit warnings, a bribery scandal, and pandemic lockdowns.
Last October, I decided it had been oversold and bought a small stake. If I’ve known it was going to take off like a rocket, I would have invested a lot, lot more.
Nothing lasts forever, and the great Rolls-Royce share price party was always going to stop at some point. I think that’s now happened.
While the stock is still up 7.78% over the last month, its performance chart suggests it has hit a plateau for now. Which is exactly what I would expect it to do. The share price has actually fallen 2.19% over the last week, and even though it’s been a bumpy time for markets as a whole, I think the dip is telling us something.
Anybody buying Rolls-Royce shares today expecting them to carry on flying to the stars should think again. It’s almost certainly not going to happen. Trading at 112.2 times earnings, it’s no longer a bargain. By that measure, it looks incredibly expensive. However, its earnings are expected to rise quite sharply from here.
In 2022, Rolls-Royce generated revenues of £13.52bn. They’re forecast to hit £14.55bn in 2023 and £15.69bn in 2024. As a result, Rolls-Royce’s forward price-to-earnings ratio for 2023 is a more amenable 30.5 times earnings. In 2024, it’s expected to fall to 22.3 times.
It’s got to slow down
When writing about Rolls-Royce, it’s obligatory to mention its net debt. However, that once daunting pile is shrinking rapidly. In 2022, management slashed it from £5.2bn to £3.3bn. It’s down to £2.85bn in the first half of this year and markets expect it to slide to £2.3bn by the end of the financial year and just £997m in 2024. That’s hardly terrifying for a company now valued at more than £18.5bn.
Rolls Royce turned £356m cash flow positive in H1, reversing last year’s £68m outflow. At some point, possibly this year, the dividend will be restored, although it won’t be much. Next year, the forecast yield is 0.68%. Tiny but likely to steadily grow.
Rolls-Royce is powering ahead on many fronts. It’s developing hydrogen-fuelled engines with easyJet, while boss Turfan Erginbilgic reckons it will win the race to develop the country’s first fleet of miniature nuclear plants “on merit”. Of course, he’s not a disinterested observer.
I think Rolls-Royce shares are still a red hot buy, but only with a minimum five or 10-year view. I’ll let the share price settle as the short-termists lose interest and drift away. Then I’ll buy it with the aim of holding for decades.
